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Chapter 6

Chapter 6. Using Credit Cards: The Role of Open Credit . Learning Objectives. Know how credit cards work. Understand the costs of credit. Describe the different types of credit cards. Know what determines your credit card worthiness and how to secure a credit card.

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Chapter 6

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  1. Chapter 6 Using Credit Cards: The Role of Open Credit

  2. Learning Objectives • Know how credit cards work. • Understand the costs of credit. • Describe the different types of credit cards. • Know what determines your credit card worthiness and how to secure a credit card. • Manage your credit cards and open credit.

  3. A First Look at Credit Cardsand Open Credit • Credit involves receiving cash, goods, or services with an obligation to pay later. • Open credit (revolving credit) is a line of credit extended before the purchase. • Pay back debt at whatever pace you like, paying a specified minimum balance each month. • Unpaid balance plus interest carries over to next month.

  4. Interest Rates • The main determinant of the cost of a line of credit is the annual percentage rate (APR). This is the true simple interest rate paid over the life of the loan. • APR is calculated the same way by all lenders, but there can be a difference in what is included. • The Truth in Lending Act requires disclosure of APR in bold print for all consumer loans.

  5. Calculating the Balance Owed • 3 ways to determine interest charges on unpaid balances: • Average daily balance method • Previous balance method • Adjusted balance method • There are numerous variations on these methods, including a two-cycle average daily balance.

  6. Calculating the Balance Owed Average Daily Balance Method • The most common method - used by 95% of bank card issuers. • Sum of daily balances/number of days in billing period. • Interest payments are based on this balance.

  7. Calculating the Balance Owed Previous Balance Method • Interest payments are charged against what was owed at the end of the previous billing period, with no credit given for the current month’s payments. • This method is very simple – but very expensive.

  8. Calculating the Balance Owed Adjusted Balance Method • Interest is charged against the previous month’s balance only after subtracting payments. • Results in lower interest charges than the previous balance method. • A favorable variation of the previous balance method.

  9. Credit Evaluation: TheFive C’s of Credit • Creditworthiness is determined by 5 C’s: • Character Sense of responsibility • Capacity Current income and borrowing • Capital Size of financial holdings/investments • Collateral Assets offered as security • Conditions Impact of economic environment on your ability to repay

  10. Determining Creditworthiness • Your credit information translates into a three digit number – your credit score – which measures your creditworthiness. • Involves the numerical evaluation or “scoring” of applicants. • Reduces the lender’s uncertainty, enabling the lender to make credit available to good risk customers at lower interest rates.

  11. How Your Credit Score is Computed • What is a good score? • The national average is 678. • This is often the minimum for receiving credit. • A good credit score doesn’t just mean that you’ll get a loan, it also means you’ll pay less for it. • A low FICO score may result in a credit card rate twice that of a high FICO score.

  12. What’s in Your Credit Report? • Identifying Information: Name, address, date of birth, SS number, and employment information. • Trade Lines or Credit Accounts: Type of account, balance, date opened, payment history, and current status.

  13. What’s in Your Credit Report? • Inquiries: Lists everyone who has accessed your report in the last 2 years. • Public Record and Collection Items: Bankruptcies, foreclosures, law suits, wage attachments, and liens.

  14. Factors That Determine Your Score • Your Payment History (35%) • Amount You Owe and Your Available Credit (30%) • Length of Credit History (15%) • Types of Credit Used (10%) • New Credit (10%)

  15. Your Payment History Lenders want to know how you have handled credit payments in the past. Amount You Owe and Your Available Credit Shows the amount you owe on your mortgage, car loan, and all other outstanding debt, along with your total available credit. Factors That Determine Your Score

  16. Length of Credit History The longer the credit accounts have been opened, and the longer you have had accounts with the same creditor, the higher your credit score. Types of Credit Used The wider the variety of credit, the higher the score. Using different types of credit indicates you know how to handle your money. Factors That Determine Your Score

  17. New Credit New applications for credit will lower your score. Those moving towards bankruptcy take all available credit to stay afloat. Factors That Determine Your Score

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